Posts Tagged ‘dividends-paid deduction’

Should we dump the corporate income tax?

Friday, March 2nd, 2012 by Joe Kristan

The current corporation income tax is ugly. It imposes two levels of tax on the same income while creating all sorts of distortions. The TaxProf explores the issue in “Should We Abolish the Corporate Income Tax?”
The post links an argument by Peter Coy in favor of the tax and one by Megan McArdle against it. The Coy argument for the tax:

The strongest argument for the corporate income tax is one that is rarely heard anymore but was widely used at its inception in 1909

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Is debt the villain?

Tuesday, January 24th, 2012 by Joe Kristan

The real devil in the details of Mitt Romney’s tax life is the tax code’s preference for debt financing, according to Tax.com’s Martin Sullivan:

As Congress desperately searches for revenue to pay for a reduced corporate tax rate, it should consider limitations of interest deductions when there is excessive debt. Even if the Romney campaign convinces you that leveraged buyouts are totally benign, there is still no reason for the United States to maintain a tax system that favors them over venture capital.

His second sentence may well be true, but it doesn’t mean the solution in his first sentence is the way there. Instead of punishing borrowers by limiting their deductions, you can instead reward equity financing by making dividends deductible.
I still think a dividends-paid deduction is a promising but under-discussed solution to the problem of high corporate rates and double taxation. Such a system would tax revenue at the corporate level when it is earned, but it wouldn’t prefer debt over equity. The problem of deductible dividend payments to tax-exempt or foreign entities could be handled with a withheld excise tax on the payments to ensure the income is at least taxed once. It would eliminate the need for a preferential rate for dividends, perhaps quieting the smug and ignorant.
Related: Why not a dividends-paid deduction?

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Why not a dividends-paid deduction?

Friday, October 7th, 2011 by Joe Kristan

Tax life would be so much easier if corporations could deduct their dividends. It would at one stroke eliminate the double tax on corporate income, greatly simplify tax planning, and eliminate the bias for debt over equity in capitalizing a business. It’s good to see that policy wonks like Daniel Shaviro are starting to take the idea seriously, even if not necessarily embracing it.
Mr. Shaviro is focused, I think wrongly, on the accounting aspects:

Reuven argues that dividend deduction would be more effective than imputation in encouraging the managers to pay dividends, on the ground they often don’t especially care about shareholder taxes but love to get company-level deductions. Thus, even if the two methods of dividend deduction and imputation are in fact economically equivalent, the former will in fact induce greater payouts.
One could certainly challenge this view on multiple grounds, but the one I emphasized, in particular because I thought it was more of a new point, reflects accepting the basic premise (at least arguendo) but then asking what the managers really care about. A common answer, with considerable real world empirical support, would be that they appear to care more about financial accounting income than about income tax liability. So the entity-level tax benefit of dividend deductibility won’t affect their behavior as strongly as Reuven anticipates unless there is an accounting benefit. But would there be?

In my world, the land of non-public, non-banking companies, nobody much cares about financial statements. They do care about being able to get cash out of the business. We go to great efforts to enable businesses to distribute profits or appreciated property without paying the normal two levels of corporate tax. In my world, a dividends paid deduction would almost certainly have a huge affect on capital structures, management incentives (management in my world is usually the owners), and willingness to pay dividends.

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